Wall Street Welcomes Back Goldilocks

Goldilocks is the term used by Wall Street to describe a nearly perfect environment
for stock values to rise. The term is being used again today, just as it was
mistakenly uttered in the middle of the housing bubble, to express the belief
held by most investors that we have once again reached equity-market nirvana--a
point in time where virtually every economic condition is just right.

However, what Wall Street regards as a nearly perfect economic environment
is really just another misinterpretation derived from believing money printing,
artificial interest rates, debt and asset bubbles can provide sustainable growth.

This same miscalculation occurred when Ben Bernanke first took the helm of
the Federal Reserve on February 1st 2006. At that time, former Chairman Alan
Greenspan had already slowly and steadily taken the Fed Funds Rate up to 4.5%,
from the 1% level back in June of 2003. The newly appointed Bernanke followed
Greenspan's lead and continued to hike the Fed Funds rate three more times
in .25% increments. By June of 2006 the Funds Rate was at 5.25% and the Ten-Year
Note climbed from 4.5% in February, to 5% by June.

Rising interest rates seemed completely innocuous back then, just as they
do today. In fact, the higher borrowing costs were being heralded as a sign
that the Fed believed stronger growth was in store; and Wall Street cheered
Bernanke and the goldilocks economy on. We all know in hindsight that the 5%
Ten-Year Note yield was enough to collapse the entire real estate market, banking
system and economy. Because of the lofty debt levels, all it took to kick start
the Great Recession was a 10-Year Note that yielded just 5%.

The truth, which belied Wall Street's ebullience, was that the massively overleveraged
private sector was teetering on collapse. And when the interest rate trigger
was pulled, the economy fell apart. At the end of 2007 the aggregate level
of debt in the economy was $49 trillion, or roughly a staggering 330% of GDP.

That aggregate level of debt has now surged to $55.5 trillion at the end of
2013, which is still about 330% of our economy. We have not deleveraged at
all. In fact, the nominal level of debt has exploded by over $6 trillion. This
onerous level of debt is merely being masked by low interest rates and an unstable
economy that is being levitated by producing renewed asset bubbles. An overleveraged
consumer and banking sector-which was the case in 2007--is certainly not a
more beneficial condition than having an insolvent government. Once interest
rates rise it will again reveal the fragile state of the economy.

There hasn't been any structural reforms made to this economy and no viable
solutions have been offered to remedy the cause of the great recession. No
tax, educational or entitlement fixes were put into effect; only our ability
to sustain consumption through re-inflating equity, bond and real estate bubbles.
The government accomplished this by substantially increasing the amount of
outstanding debt and having our central bank monetize most of it.

The Ten-Year Note has already climbed from 1.5% last year, to 3% today. We
are now only 200 basis points away from another complete meltdown in stocks
and real estate prices. The Fed will learn a painful lesson this year. Namely,
that it does not control the long end of the yield curve. A zero percent Fed
Funds Rate does not preclude a 5% Ten-Year Note from being realized. Once the
Fed's monthly allotment of asset purchases dwindles to around $25 billion per
month, I expect the benchmark interest rate to approach that key 5% level.

The Fed can still keep short-term rates low as long as it wants, but that
will eventually create runaway inflation, ravage the economy and push the long
end of the yield curve higher. Or, it can alternatively stop QE and raise the
Fed Funds Rate, which will prick asset bubbles, cause government revenue to
plummet and send debt service payments soaring. In either the case, the two
immutable facts are that the U.S. has a historically-unprecedented level of
debt and interest rates must soon mean revert. Much the same case can be made
for Japan and the Eurozone as well. That toxic combination is what Wall Street
describes as a "Goldilocks scenario."

How all this ends up is sadly very clear. The Fed's next major undertaking
will not be how it can gradually raise interest rates in the context of an
improving economy-which is the current consensus view, but rather, how much
money it will have to print to keep borrowing costs from spiraling out of control.

PPS is a Registered Investment Advisory Firm that provides money management
services and research for individual and institutional clients.

Michael is a well-established specialist in markets and economics and a regular
guest on CNBC, CNN, Bloomberg, FOX Business News and other international media
outlets. His market analysis can also be read in most major financial publications,
including the Wall Street Journal. He also acts as a Financial Columnist for
Forbes, Contributor to thestreet.com and is a blogger at the Huffington Post.

Prior to starting PPS, Michael served as a senior economist and vice president
of the managed products division of Euro Pacific Capital. There, he also led
an external sales division that marketed their managed products to outside
broker-dealers and registered investment advisors.

Additionally, Michael has worked at an investment advisory firm where he helped
create ETFs and UITs that were sold throughout Wall Street. Earlier in his
career he spent two years on the floor of the New York Stock Exchange. He has
carried series 7, 63, 65, 55 and Life and Health Insurance Licenses. Michael
Pento graduated from Rowan University in 1991.